| FIN 591
Section 62628 |
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Studint name 2 Studint name 3 Studint name 4 |
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Introduction: 3
AutoZone: 4
- How has AutoZone’s stock price performed over the previous five years? What other financial measures can you cite that are consistent with the stock price performance?. 5
- How does a stock repurchase work? Why would a company use this tactic? What impact does it have on: EPS? ROIC?. 7
- How much of AutoZone’s stock price performance should we attribute to the share repurchase program?. 9
- Assume that AutoZone is planning to stop its share repurchase program. What would be the best alternative use of those cash flows? Why?. 10
- What should Johnson do about his holdings of AutoZone shares?. 12
Numerical analysis: 14
- Estimate the impact of share repurchases on financial performance metrics. 14
- Estimate the impact of shares repurchases on ROIC.. 14
Conclusion: 15
Resources: 16
Introduction:
In the business sector, shareholders invest in companies in exchange for capital appreciation and income. Each company has the option to decide what will do with the free cash flow either, reinvesting the cash flow in the company to grow or distribute it to the firm’s shareholders. This option is based on many factors such as the stock price, tax structure and long-term goals. Moreover, if the company reinvest the free cash flow, then it could start a new project or add to retuned earnings for future use. However, if the firm used it in distribute to its shareholders, it can do by shares repurchasing or paying dividends (Dividend polices). This process of distributing the cash flow to the shareholders called, management of the firm’ equity. Business & Finance homework help
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Share repurchase means the company buyback it shares from the shareholder in order to transfer surplus cash to its shareholders. In addition, the price of share repurchases come with premium to the current market price, which motivate them to sell their shares. This process reduces the number of share outstanding. Another reason for it, sometimes the company sees the company’s share price is undervalued (the market price is lower than the book value), by making the buyback the price is push upward.
The dividends are after tax- profits and its common way to retune the surplus cash to shareholders. Many of shareholders looking for stabile cash flows, that make the dividends very important features in the investment decision especially those who are depend on it.
Companies develop a strategy between dividend and share repurchase strategy because it requires some legal requirements, restrictions for issuing of new shares for a period of time. Also, they need to keep a certain debt-to-equity ratio, funding sources, and so on.
AutoZone:
AutoZone, an aftermarket auto-parts retailer. The first AutoZone store opened in Forrest City, Arkansas, in 1979, under the name Auto Shack. The company changed its name to AutoZone in 1987, and implemented the first electronic auto-parts catalog for retail stores. In 1991, AutoZone went public, trading under the ticker symbol AZO on the New York Stock Exchange.
Since 2012, AutoZone has grown to become the largest retailer of auto parts and accessories in the United States, with more than 65,000 employees and 4,813 locations in every state in the contiguous United States, Puerto Rico, and Mexico. Over the past 15 years, AutoZone has been profitable, and its stock price has appreciated significantly.
A particular issue in this case concerns Mark Johnson, a portfolio manager at Johnson & Associates, who was reviewing his investments, which included his position at AutoZone. Johnson was concerned that the reduced position of Edward Lampert (a prominent shareholder who had begun liquidating his shareholdings in AutoZone) could lead to the company ceasing to buy back shares if the company stopped using share repurchases as a method of distributing cash to shareholders. Business & Finance homework help
We will analyze AutoZone’s stock price over the last five years and explain how stock repurchases work and how they impact EPS and ROIC. In addition, the case lists a number of alternatives uses for the free cash flow generated by AutoZone if it decided to discontinue it repurchase program. The report concludes with a recommendation for Mark Johnson regarding his AutoZone stock holdings and what he should do.
- How has AutoZone’s stock price performed over the previous five years? What other financial measures can you cite that are consistent with the stock price performance?
Since 1997, AutoZone stockholders have had a sharply price increase, with an average annual return of 11.5%. In the previous five years, the stock price had risen considerably, reaching $348. The United States’ economy had its worst recession since the Great Depression in 2008, and the recovery that followed was abnormally slow. Because the auto-parts industry is generally counter-cyclical, strong stock price appreciation was a result of the U.S. economy’s slump. To further show, the economy and the number of kilometres driven by a car are both closely related and connected to the company’s growth and stock price. When the economy was struggling and unemployment was high, fewer new automobiles were purchased, and older cars were maintained on the road for longer periods of time, necessitating more regular maintenance. Business & Finance homework help
As a result, the auto parts retail sector saw a significant increase in top line revenue. With over 65,000 employees and 4,813 locations, AutoZone had grown to become the largest retailer of automobile replacement parts and accessories in the United States by 2012. As seen in the chart below, AutoZone’s financial results mirror its stock price performance, including net sales rising from $6,169,804 to $8,072,973 between 2007 and 2011, a 30.85% increase. Additionally, during the same time, cost of sales increased by 27.430 %, from $3,105,554 to $3,953,510. The increase in cost of sales is less than the growth in net sales, resulting in a 34.4 percent increase in gross profit from $3,064,250 to $4,119,463 during the previous five years. Furthermore, AutoZone’s operating profit increased by 41.65 % from $1,055,266 in 2007 to $1,494,803 in 2011, proving the company’s efficiency and profitability. EPS and the stock price of AutoZone are strongly linked, and EPS is a major driver of the stock price. Between 2007 and 2011, basic EPS increased by 130.97%, while diluted EPS increased by 128.25%.
In addition, AutoZone’s management used after-tax return on invested capital (ROIC) as the main measure for determining the company’s value creation for its capital suppliers. AutoZone returned capital to its equity owners in 1998 by repurchasing shares, which was funded by high operating cash flow and debt issuance.
As a result, the number of outstanding shares was reduced, resulting in higher earnings per share. Between 2007 and 2011, the number of outstanding shares fell by 39%, and shareholders’ equity fell to a negative 1.2 billion in 2011.
As a result, AutoZone’s invested capital has stayed relatively constant since 2007, resulting in increasing earnings and a good return on investment, as demonstrated in exhibit 9 in the case. Because of these two factors, the stock price has risen during the last five years. The AutoZone cash flow statement indicates that net cash supplied by operating operations was $1,291,538 in 2011 and debt was $500,000, indicating that the $1,466,802 in treasury stock purchases in 2001 were fully covered by free cash flow and debt. Business & Finance homework help
- How does a stock repurchase work? Why would a company use this tactic? What impact does it have on: EPS? ROIC?
As mentioned before, the company can use the free cash in two ways, the first is to reinvesting the cash flow in the company for growing purpose or as AutoZone do distribute it to the firm’s shareholders. They used the free cash flow in repurchasing (buyback) shares “the transaction in which the stock issuer buys back its shares from investors”. these shares are held in the company treasury and they become treasury shares (stock). After the buyback transaction, the company must make the accounting entries for it by debited the Treasury share account and credited the cash. This new account is a contra-stockholders equity account and it shows in the balance sheet and it has a negative single.
Many companies use the repurchasing shares tactic for many reasons such as, when they reporting that their stock are undervalued (the market price is lower than the book value), so they choose to buyback it shares to mateine their market value. Moreover, getting advantage of income tax. If the company distribute its cash flow as a dividend, then the shareholders are taxed at personal income tax rate in the same year dividends are received. But, if its buyback shares the shareholders will get capital gains; also, the capital gains are taxed at a lower rate. Also, companies looking for maintain the capital structure by making the correct allocation between debt and equity. Usually purchasing of shares is modify and maintain balance of debt and equity.
In addition, buyback provide the flexibility more than dividends, because the dividends must be payed immediately rather than repurchase share it’s takes a period of time and sometimes the company can cancel it and use the cash flows in the interest of the company. Earnings per Share (EPS) is the most important measurement for valuing a company and we can calculate by dividing the total earnings by the number of shares outstanding. The impact of buyback shares will be positive on EPS, if the number of outstanding shares is reduced, the EPS will increase and that will make the company more favorable for investors. Also, the increase of EPS will make the price of the stocks be higher. Business & Finance homework help
Also, the repurchasing shares will return on Invested capital (ROIC), it’s one of the best metrics to evaluate corporates performance. Keep in maid, there are some factors will be removed when we calculate the ROIC like non-economic accounting issues and financial leverage impacts. As the transaction done it shows on the balance sheet as a reduce in the company’s cash holdings, and that will reduce the total assets and total shareholders’ equity also. This is shown in this case where there was a significant reduction of both the shares outstanding and equity capital. Shares outstanding had dropped from $65,960 in 2007 to $40,109 2011 by %39.19, and shareholders’ equity had been reduced to a negative $1.2 billion in 2011 it was $403,200 in 2007 that means it’s reduced by -%411.06. As a result, AutoZone management focused on the opportunities that led to revenue growth and capital stewardship. So, it’s resulted in that strong working capital.
We can see the relationship between the share repurchased and ROIC in exhibit 28.9, the ROIC has a strong increase after the share repurchase. Moreover, this transaction makes the growth of AutoZone to be huge and stable where the economy was in recession this had made a large impact on issuing a likable ROIC. we can say now, ROIC is clearly certifying that AutoZone is offering strong returns for its investors.
Stock price performance and share repurchase has a positive relationship due to many reasons:
- Decreasing in the number of shares outstanding
- Increase in the stock price during the repurchasing process
- Higher EPS due to decreasing in shares outstanding
In addition to collecting earnings per share, investors use the company’s number of shares outstanding to measure company performance. The number of outstanding shares in 2011 was 43,603, which is lower than the number of outstanding shares in 2007. In the last five years, diluted earnings per share increased 128% from an $8.53 per share in 2007 to $19.47 per share in 2011. Additionally, AutoZone’s stock price has also increased from $120 to $298 over the same period. This means that the increase in the number of outstanding shares will result in a decrease in the price of the stock and, on the other hand, the increase in the number of outstanding shares will result in a decrease in the price of the stock. Business & Finance homework help
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AutoZone’s stock price performance was strongly correlated with its good performance.
| 2007 | 2008 | 2009 | 2010 | 2011 | |
| EPS | 8.62 | 10.14 | 11.89 | 15.23 | 19.91 |
| Price | 119.9 | 139.47 | 158.07 | 272.59 | 324.97 |
| Shares Outstanding | 65,960 | 59,608 | 50,801 | 45,107 | 40,109 |
- Assume that AutoZone is planning to stop its share repurchase program. What would be the best alternative use of those cash flows? Why?
AutoZone could manage its cash flows in a variety of ways if it chooses to end its share repurchase program. These options include:
- Paying out dividends.
- Expanding the number of stores
- Acquiring additional auto-parts retail businesses
- Repaying some of the company’s long-term debt.
After evaluating the options, expanding the business with the company’s operational cash flows is regarded a reasonable choice. This might be achieved in one of two ways: by opening branches (both domestically and nationally) or by acquiring other auto-parts retail businesses. This expansion or growth is necessary for AutoZone to remain at the top as the nation’s largest auto-parts store and prevent competitors from developing a foothold in those new markets. AutoZone Inc. currently operates multiple stores outside the United States, including in Puerto Rico and Mexico. AutoZone’s management, on the other hand, must be aware of the risks that come with such expansion. There’s no guarantee that the expansion will produce the same outcomes that AutoZone now does.
AutoZone has been able to buy around 800 stores from its competitors since 1998. As a result, AutoZone is well aware that, as an option to the share repurchase program, it can use its operational cash flows to acquire its competitors’ existing stores. These stores would be deemed a smart investment because they would become productive and useful far faster than new ones would (due to the fact that they are already built and available).
However, there are several disadvantages to this method. The auto-parts market is deemed oversaturated or mature, implying that there are only a few competitors to be bought (fewer targets for acquisition). Furthermore, this suggests that the acquisition move could be stymied by the U.S government Department of Justice (as it would be considered a potential act of monopoly).
We believe AutoZone should not use its operating cash flows to expand its business because:
- The auto-parts store market is already mature/oversaturated.
- There really are limited places available for expansion (domestically)
- International expansion is risky and unpredictable.
- It would be difficult to gain a larger share of the market without breaking monopolistic rules.
Additionally, AutoZone might spend some or all of its operational cash flows to pay down some of the loans it had collected over the years, most of which had been used to fund the share repurchase. With a negative book-equity position and such a huge debt load, it is suggested that AutoZone employ at least some of its cash flow to pay down debt. This is for two reasons: the first is that if AutoZone gets into financial problems, it may find it difficult to make interest payments and roll over maturing debt. Another point to consider is that AutoZone could lose its investment grade, making future debt financing more difficult to come by and more expensive.
AutoZone might also distribute its operating cash flows to investors in the form of dividends. The company could choose to distribute the cash as dividends, share repurchases, or a mix of both. Dividends were considered as a way to deliver cash to existing owners, whereas a share-repurchase program would only pay cash to those who were selling their shares.
Dividends, on the other hand, were taxed at the expense of other stakeholders in the year received, while non-selling shareholders might defer paying taxes until they sold the shares, if a share-repurchase program succeeded in increasing the share price. Dividends were also thought to be sticky, which meant that the market expected a company’s dividend to stay the same or increase year after year. But on the other hand, market did not consider share repurchases to be sticky because the quantity repurchased varies from year to year. Business & Finance homework help
As several companies do, AutoZone can choose to return shareholder cash through both dividends and share repurchases. In the majority of these situations, the corporation paid a consistent but tiny cash dividend and then repurchased shares at variable levels each year, depending on the circumstances. The advantage of this strategy was that it provided shareholders with a stable dividend while simultaneously providing price support through share repurchases.
Finally, AutoZone should decide whether or not to take advantage of all of these options and implement one or more of them, depending on the company’s needs.
Mark Johnson has three different options when it comes to his AutoZone Shares holdings: sell, purchase, or hold. Each of these solutions has its own set of benefits and drawbacks, which are detailed below:
If Mark Johnson sells his stock, he will have a better chance of earning a larger return before the economy is growing and becomes strong, since if the economy grows and becomes strong, the value of AutoZone shares will fall, lowering Mark Johnson’s return.
Purchasing AutoZone shares has a favourable aspect if the stock price and value rise; but, if the share price and value fall, he will lose money, and the same will be true if he holds AutoZone shares.
Also, if AutoZone decided to suspend repurchasing shares, they would have extra cash flow that could be used for expansion, new product launches, or debt repayment. Utilizing this cash could have a favourable impact on AutoZone; but, if the firm is able to manage its operations, the share price and EPS could fall dramatically. On the other side, if the company is unable to effectively manage its operations, the stock price and earnings per share (EPS) may fall, disappointing investors.
Johnson is one of the largest shareholders in AutoZone, and he was concerned when he heard that Lampert, the company’s majority shareholder, was quickly liquidating his interests (AutoZone). Johnson was also worried about the future performance of AutoZone’s share price because he didn’t know why Lampert was selling his investment, which could have a negative impact on AutoZone’s investors. However, it is not required that Lampert liquidating his stake is a bad indicator; he may be liquidating his AutoZone stock for other personal reasons, or for better investment opportunities, since he may be a financial buyer seeking a higher return, thus we feel Johnson should keep his AutoZone shares. AutoZone’s financial statistics demonstrate that the company is constantly developing, with EPS, ROIC, and stock price, which are the most crucial variables for investors, all expanding at a desirable rate.
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We believe that AutoZone’s investors will benefit financially from the substantial increase of AutoZone’s stock prices in the future. In fact, AutoZone’s financial statement shows no signs of a decline in its stock price, indicating that the company has been creating a quantifiable value for a long time and that it will continue to do so in the future.
AutoZone has a high bad debt ratio, which has a negative impact on the financial security index. The company must either increase capital in debt to develop or pay a higher cost of capital. Also, due to its large debt ratio, AutoZone’s policy of using debt to repurchase stock is inefficient. If AutoZone does not have enough funds to continue with this policy, the share price will fall. While the policy of repurchasing shares with debt would increase demand on the stock market, causing the business stock price to rise above its real value.
Our recommendation to Mark Johnson is to keep his AutoZone stock because the United States is experiencing a recession and will take many years to recover. When a result, as the US economy improves, Mark Johnson’s stock price will rise, and the maximum level of AutoZone stock will result in a high ESP. Business & Finance homework help
Numerical analysis:
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2007 | 2008 | 2009 | 2010 | 2011 |
| Gross Profit Margin | 49.67% | 50.10% | 50.12% | 50.41% | 51.03% |
| Intrest coverage ratio | 10.20 | 11.08 | 9.53 | 9.51 | 9.91 |
| Current ratio | 99.32% | 102.66% | 94.64% | 85.24% | 81.39% |
| ROE | 147.7% | 279.3% | -151.7% | -99.9% | -67.7% |
| ROA | 12.40% | 12.20% | 12.35% | 13.25% | 14.46% |
| Leverage Ratio = Debt to equity ratio | 10.92 | 21.89 | -13.28 | -8.54 | -5.68 |
| Debt-To-Capital Ratio | 0.92 | 0.96 | 1.08 | 1.13 | 1.21 |
| 2007 | 2011 | |
| Gross Profit Margin | 49.67% | 51.03% |
| Intrest coverage ratio | 10.20 | 9.91 |
| Current ratio | 99.32% | 81.39% |
| ROE | 147.7% | -67.7% |
| ROA | 12.40% | 14.46% |
| Leverage Ratio = Debt to equity ratio | 10.92 | -5.68 |
| Debt-To-Capital Ratio | 0.92 | 1.21 |
Net sales have increased for 30.85% from 2007 to 2011. Cost of sales also increased during that period, but at lower rate of 27.30%, what helped in additional improvement of gross profit margin.
By reducing the capital employed, return measures also increase (ROA, ROIC).
The buyback will simultaneously shrink shareholders’ equity on the liabilities side by the same amount. As a result, performance metrics such as return on assets (ROA)
As what we said before, as the repurchase done it shows on the balance sheet as a reduce in the company’s cash holdings, and that will reduce the total assets and total shareholders’ equity also. This is shown in this case where there was a significant reduction of both the shares outstanding and equity capital. Shares outstanding had dropped from 2007 to 2011 by %39.19, and shareholders’ equity had been reduced by
-%411.06 from 2007 to 2011. In a normal cases we can say return on equity (ROE) increases because there is less outstanding equity but here the shareholders’ equity had been reduced too much until being in minis, that’s cause an reduction on the ROE by -67.7% in 2011.
With holding the cash, the debt will increase as showing in 2007 to 2011 by 61.8%, and considering the reduction of equity that’s reflecting in reducing the Debt to equity ratio.
As well as the current ratio are decrees as we use the cash in repurchasing and there is not enugh cash even it’s stell positive and it’s meam there is
Conclusion:
We strongly feel that AutoZone should not consider ending its share repurchasing program and should continue with it after examining all possible scenarios for managing their business cash flows. AutoZone was able to slowly improve the price of their shares by implementing their share repurchase program/strategy (as the market views their share repurchases as indirect dividends). Any movement from the company’s repurchasing program could be viewed by the market as a negative signal, leading to a loss of investor confidence in the company.
However, if AutoZone decides to change their strategy and instead distribute dividends, they will have to keep the dividend amount stable or improve it to always keep the investors happy. AutoZone has been able to display a continually incremental and improved ROIC throughout the years. The negative effects as well as the dangers associated with the expansion plans, whether domestically or nationally, will almost certainly result in a decrease in the company’s value, as with the other options for utilizing the company’s operational cash flows.
As a result, if the price of AutoZone’s shares continues to rise, Johnson & Associates should hold on to its investment and focus on expanding its business inside the firm. Business & Finance homework help
Resources:
- Bruner, R.F., Eades, K.M. and Schill, M.J. (2018) Case Studies in Finance: Managing for Corporate Value Creation, McGraw Hill, 8th edition.
